Sunday, 03 Feb 2013 01:06 PM

By Michael Kling

The financial system is like a supernova star that grows until it runs out of energy, explodes and collapses, warns Bill Gross, managing director of fund giant Pimco.

Its fuel is central banks’ loose monetary policies, which are becoming increasingly ineffective at promoting real economic growth, Gross writes in his monthly investment outlook report.

Total U.S. credit outstanding is now at $56 trillion and growing, Gross writes. “It is a monster that requires perpetually increasing amounts of fuel, a supernova star that expands and expands, yet, in the process begins to consume itself.”

Expanding credit increasingly goes to creditors and market speculators and less and less to real economic growth. Instead of promoting small-business development, investment banking is dominated by leveraged speculation and Ponzi finance when additional credit is needed just to cover interest payments.

“Each additional dollar of credit seems to create less and less heat,” he states. “In the 1980s, it took $4 of new credit to generate $1 of real [gross domestic product]. Over the last decade, it has taken $10, and since 2006, $20 to produce the same result.”

To see the impact of zero-based interest rates, look at Japan, which he calls a “credit market supernova, exploding and then contracting onto itself.”

“Money and credit may be losing heat and running out of time in other developed economies as well, including the U.S.,” Gross writes.

His supernova example is “more instructive than literal,” he adds, saying the end of the global monetary system is not near.

Still, we’re running out of time, and the countdown to the financial system’s end starts when investments have too much risk for too little return.

Central banks and private banks must generate real, or at least nominal, economic growth or the “risk of credit market entropy will increase.”

Gross recommends investors prepare for inflation by buying short-term bonds and TIPS, moving money to countries with less debt and safer credit systems such as Australia, Brazil, Mexico and Canada, investing in global equities with stable cash flows and seeking gold and other commodities that you “can sink your teeth into.”

Many other experts are not as fearful as Gross is.

Goldman Sachs’ Abby Joseph Cohen predicts corporate earnings growth of 12 to 13 percent this year.

“The U.S. economy is showing some dynamism,” said Cohen, who sparred with Gross at a Barron’s Roundtable discussion. “Exports have been robust. Only one sector of the economy isn’t growing: government spending.”

Jack Bogle, founder of The Vanguard Group, says the rise in the Dow Jones Industrial Average recently means little for the economy.

“I don't think the economic signs are going to change very much.” Bogle anticipates growth of 2 to 2.5 percent for this year. “That hasn't changed whether the Dow is 14,000, or 12,000 or 16,000.”

Editor's Note: Economist Warns: ‘Money From Heaven a Path to Hell.’ See Evidence.

© 2013 Moneynews. All rights reserved.